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As the fiscal-cliff uncertainty grew at year end, and as volatility began to rise, many traders figured it was time to buy volatility. As it turned out, the Chicago Board Options Exchange's Volatility Index, or VIX -- the market benchmark for volatility -- exploded upward, but only briefly. VIX rose from 15.57 on Dec. 18 to 22.72 on Dec. 28 -- a gain of 46%.

The discrepancy in the performance of VIX futures and the VIX relates to differences in the way both are calculated. Specifically, they are priced on the basis of different sets of S&P 500 index (SPX) options.

It always upsets me to hear TV commentators saying things such as, "If you had bought VIX last week, you could have hedged your portfolio since VIX was up 15%."

First, you can't buy the VIX, as noted. Second, on such a small move in the VIX, especially in a fairly quiet market, you might not make anything at all on the purchase of a VIX derivative.

In theory, buying volatility as a portfolio hedge is an excellent idea. During the financial crisis of 2008 it paid off handsomely. In fact, if you buy volatility derivatives as disaster insurance, they work fine. They are there for you if something catastrophic happens. But buying volatility protection often isn't particularly useful for a small stock-market correction.

To me, this seems proper. It makes more sense to buy short-term, out-of-the-money options and keep doing so, as longer-term calls won't track the VIX well. This is a low-cost way of having disaster protection in place if another financial crisis, flash crash, or even rapid market-decline occurs.

THE RECENT GAINS in the VIX were short-lived, as the Volatility Index subsequently plunged to 14.68 from 22.72 in two trading days. According to the CBOE, that marked a record two-day percentage loss for the index. The rise and fall created a peak spike in the VIX chart, and such spikes are an intermediate-term buy signal for stocks.

Is it even necessary to buy volatility protection when there is a buy signal in effect? The answer depends on your risk outlook. It has been popular for institutional investors to buy stocks and volatility protection since the November 2011 market lows. In doing so, they inflated the cost of volatility protection. Since then there hasn't been a major stock-market correction, so most of the money spent on portfolio protection was lost, although the portfolio's value increased with rising stock prices.

We generally advise clients to keep a partial long-volatility call position in place at all times, moving to full protection when indicators begin to turn bearish for stocks.